A U.S. Attorney's office has alleged that PayPal violated laws regarding the processing of online gambling payments, and is asking parent company eBay to hand over nine months of the gambling-related earnings in settlement.

The U.S. Attorney for the Eastern District of Missouri told eBay that its online payment service violated provisions in the USA Patriot Act between October 2001 and July 2002, according to eBay's annual report, filed Monday with securities regulators. Under the act, it is prohibited to transmit funds known to have come from a criminal offence, or that are intended to promote or support unlawful activities.

The agency is seeking to collect any earnings that PayPal received from online gambling merchants during the nine-month period, as well as interest. Last year, PayPal received 6 percent of its revenue from online gambling, according to its filing with the Securities and Exchange Commission.

eBay, however, takes issue with the U.S. Attorney's allegations: “PayPal acted in the good faith belief that its conduct did not violate (the USA Patriot Act), and PayPal calculates that the amount of its earnings from online gaming activities was less than asserted in the (U.S. Attorney's) letter.'

The San Jose, Calif.-based auction company, which received the U.S. Attorney's notice on Friday, is reviewing the matter and has not decided whether it will pay the requested settlement price, according to Kevin Pursglove, an eBay spokesman.

If a settlement is reached, it won't be the first time PayPal has paid up over processing online gambling payments. Last August, the service reached a settlement with the attorney general for the state of New York, under which it ceases processing payments for New York online gambling merchants and also paid the state $200,000 in penalties.

eBay, which acquired PayPal in October, has halted the practice of processing online gambling paymentsThe company says the most recent controversy could hit the service hard: 'PayPal's business could suffer if customers use its system for illegal or improper purposes, or if usage of its system is reduced because of increased verification requirements.'

The company is aware that PayPal's business could also suffer if future regulation under the USA Patriot Act requires it to revise its process for verifying the identity of its customers. The USA Patriot Act, signed into law in 2001, gives law enforcement agencies greater latitude in monitoring Internet usage and sharing information. The law is designed to reduce the prospect of terrorist attacks.